The ETF Portfolio For Millennials

Hypothesis: You have $10,000 in a rollover IRA and you’ll spend the money four decades from now. Where to invest it?

Here I present a model portfolio of exchange-traded funds that is simple to implement and very economical. It beats trying to beat the market with stock picking and it’s cheaper than paying someone else to try to do that. It’s even cheaper than a Target Retirement fund from Vanguard.

The portfolio is made up of six funds that rank high in the Forbes Best ETFs survey. Vanguard makes a strong showing in this survey, but it does not have the top slots to itself. It’s getting quite a run for its money from BlackRock’s iShares, State Street’s SPDRs and Schwab’s funds.

The Best ETFs scorecard is based on a unique analysis by Forbes of investment costs. We take into account not only the usual expense ratios but also bid/ask spreads and cost offsets from securities lending. We aim Best ETFs at investors who see costs as paramount in the selection of an index fund.

The owners of several trillion dollars see investing this way. Join them and you will save a large pile of money between now and when you retire.

Best ETFs

Forbes

These days you can get a pretty good deal from a target date fund, one of those prefabricated cocktails of stocks and bonds. But not good enough. You can do better by mixing your own drinks. Create a cheap retirement fund by blending pure stock ETFs and bond ETFs.

If you’re a millennial—born, say, in the 16-year span 1981-1996—then you are a prime target for Vanguard Target Retirement 2055, for people leaving the workplace 37 years from now. A $10,000 stake in that product will cost you $184 over the next ten years. The conservative do-it-yourself portfolio I propose will cost only $27. A riskier Best ETFs portfolio, containing a higher dose of cheap stock funds, costs a mere $12.

We’re not nitpicking over a few dollars. When you’re done saving you should have at least $1 million. (That’s roughly what it would cost you to replace a maximum Social Security payout beginning today.) So look at those costs for $10,000 and multiply by 100. To be sure, you’ll have less than $1 million at work most of the time, but also remember that our cost figures are per decade, and you’re saving for four decades.

In very round numbers: A moderately expensive fund like Vanguard 2055 will make you $18,000 poorer. My Best ETFs recipe will nick you only $3,000.

The six-fund blend above has a 60/40 mix of stocks to bonds. Maybe that’s too conservative for you. Indeed, just about all the experts will tell you that if you’re under age 40 you should be almost entirely in stocks, because stocks do better over the long run and a long horizon will enable you to shrug off the next crash.

But will you shrug off the next crash? We won’t know until it happens.

If you are a millennial you are old enough to remember the crash of 2007-2009, but not old enough to have had a retirement account wrecked. You can barely remember the crash of 2000-2002. You weren’t even born when the crash of 1973-1974 arrived.

So we don’t know if you’ll panic during the crash of…..when will it be? 2020-2021? A 40% dose of bonds may give you the stamina to stand pat instead of selling out at the bottom.

If you want to go with the mainstream experts, though, it’s easy to make an adjustment. For risk takers, here’s a version of the Best ETFs portfolio that is weighted 80/20 in stocks to bonds. It’s built out of the same six Best ETFs funds:

Best ETFs

Forbes

How did my two portfolios get to be such a bargain? ETFs are cheap for two reasons. One is a price war among the big ETF vendors. There’s competition in target date funds, too, but not as fierce.

The other reason is the cost offset from lending out shares to short-sellers. That offset is enough to move some stock funds into negative cost territory.

Compare the Best ETFs portfolios with Vanguard Target Retirement 2055. The target fund is an open-end, so it benefits from an absence of bid/ask spreads. It also benefits just as ETFs do from securities lending. And still it’s a lot more expensive than either of my ETF blends. Vanguard’s official cost figure for Target Retirement, by the way, is even higher than my $184.

It’s easy to create a cheap retirement portfolio in a self-directed IRA. At Vanguard, take advantage of its new commission-free ETF trades. At other brokerage firms you’ll probably get at least some of the funds on my list commission-free, and you may be able grab a sign-on bonus for opening the account.

What about the 401(k) account at your job? Cutting costs is more of a challenge there. Your employer may (a) charge you $50 a year to access ETFs via a brokerage window or (b) not even open the window. Solutions to those problems: (a) wait until your balance tops $100,000 before switching into ETFs, and (b) organize a protest rally outside the benefits office.

There’s bad news and good news for your retirement. The bad news is that the powerful bull market your parents enjoyed is mostly over. The good news is that you can get much cheaper money management than they had.